Foreign banks bracing for tough U.S. Fed capital rules

By Douwe Miedema

5 Min Read

An eagle tops the U.S. Federal Reserve building's facade in Washington, July 31, 2013.Jonathan Ernst

WASHINGTON (Reuters) - Overseas banks look set to win only minor concessions when the Federal Reserve signs off on new capital rules next week, as they become increasingly resigned to the fact that the cost of doing business in the United States will go up.

The Fed, whose board of governors meets on Tuesday, will require overseas banks to hold as much capital in the United States as their local rivals.

The reform is designed to address concerns that U.S. taxpayers will need to foot the bill if European and Asian regulators treat U.S. subsidiaries with low priority if they need to rescue one of their banks.

Foreign banks with sizeable operations on Wall Street such as Deutsche Bank and Barclays have pushed back hard against the plan because it means they will need to transfer costly capital from Europe.

Fed Governor Daniel Tarullo, in charge of financial regulation, has given little sign the Fed will relent, however, and the financial industry expects no wholesale change from when the proposed rule came out in December 2012.

"(He) certainly does not suggest that they're moving toward greater leniency, at least for the largest institutions," said Greg Lyons, a partner working on banking regulation at law firm Debevoise & Plimpton in New York.

The Fed declined to comment.

Europe and the United States have squabbled over how to apply their rules to overseas banking units, and the Fed's plan, as well as its tougher reading of globally agreed capital rules, have widened the rift.

The Fed proposal requires the largest overseas banks to set up an intermediate holding company in the United States that will be subject to the same capital, leverage and other requirements as U.S. bank holding companies.

This would give banks less flexibility to move money around than under the current rules, which allow banks to use capital legally allocated in their home country. In some cases, the U.S. rules are tougher than elsewhere.

TIT FOR TAT

One of the changes the Fed's five-member board may make when it votes on the final rule is to lower the number of banks that need to comply with the strictest requirements, several people working in the industry said.

"We believe ... that they ... carved it back to those foreign banks that have $50 billion in assets here in the U.S.," said one industry source.

So far, the cutoff was for U.S. units with $10 billion in assets, and the tweak would mean only the largest 18 foreign banks would fall under the final rule, a sharp drop from the 26 under the proposal, this source said.

The United States used to rely on foreign supervisors to watch overseas banks, allowing them to hold less capital than their domestic counterparts, on the assumption that the parent company was sufficiently capitalized.

But that policy ended after the Fed extended hundreds of billions of dollars in emergency loans to overseas banks during the financial crisis, which sparked fears foreign banks were not sufficiently capitalized in the United States.

Deutsche could face a hefty capital shortfall because of the plans, bank analysts have said, though Germany's largest bank has said it is sufficiently capitalized under "all scenarios" after a capital increase last year.

Morgan Stanley in a recent research note said that funding costs would go up for foreign banks, with Deutsche most heavily affected, and that it would also be forced to reduce its business and see revenues and profits drop.

Now that the changes seem to have become inevitable, bankers are pushing for more time, because setting up a new legal structure is not an easy task.

"Technically, (setting up) an intermediate holding company is intensely difficult," said one senior banker, asking not to be identified by name or affiliation.

Europe has warned of tit-for-tat action, with European Union financial services commissioner Michel Barnier saying in October the bloc would draw up similar measures if the Fed pushed ahead with its plans.

But Washington, worried that Europe's plans to shield taxpayers from having to bail out a bank when the next crisis happens aren't as far advanced as those in America, has taken an uncompromising stance on such issues.

And even some bankers see benefits in the new rule, given the often-acrimonious past problems when different countries had to save a bank with operations across borders.

"It simplifies the U.S. part of the bank structure," said a second senior investment banker, citing the example of the troubled rescue of Franco-Belgian bank Dexia.

"If it's implemented in a balanced way, it could improve the relationship between the home and host regulator, and strengthen cross-border cooperation in resolution."